Net Present Value

Net Present ValueFor new project managers

Net present value can be tricky to learn, but its really very simple.

In this presentation I try to deliver an explanation of what it is

And how to use it.

Your feedback to this slide pack would be appreciated

Lets get on with it

What is Net Present Value?

What is Net Present Value?

What is Net Present Value?Net Present Value

Net Present ValueNet present value (NPV) is a standard method for the financial appraisal of long-term projects.

Net Present ValuePresent value of net cash flows

What is it?Net Present ValueCash flow is discounted back to its present value (PV).

20092008201020112012In todays termsIn todays termsIn todays termsIn todays termsRevenues Costs = ?

Simple, right?

What is it?But what is it?

Each cash inflow/outflow is discounted back to its present value (PV).

Then they are summed.

20092008201020112012In todays termsIn todays termsIn todays termsIn todays termsRevenues Costs = ?

Each cash inflow/outflow is discounted back to its present value (PV).

Each cash inflow/outflow is discounted back to its present value (PV).

Then they are summed.

Each cash inflow/outflow is discounted back to its present value (PV).

Then they are summed.

Each cash inflow/outflow is discounted back to its present value (PV).

Then they are summed.

Each cash inflow/outflow is discounted back to its present value (PV).

Then they are summed.

Each cash inflow/outflow is discounted back to its present value (PV).

Then they are summed.

20092008201020112012In todays termsIn todays termsIn todays termsIn todays termsRevenues Costs = ?

Got it yet?

Each cash inflow/outflow is discounted back to its present value (PV).

Year 1s value in todays terms,Year 2s value in todays terms,Year 3s value in todays terms,Year 4s value in todays terms,etc

2. Then they are summed.

Year 1 +Year 2 +Year 3 +Year 4 +Etc------------= Sum

But what is the formula all about?

t - the time of the cash flow N - the total time of the project r - the discount rate (the rate of return that could be earned on an investment in the financial markets with similar risk.) Ct - the net cash flow (the amount of cash) at time t (for educational purposes, C0 is commonly placed to the left of the sum to emphasize its role as the initial investment.)

What is it?t

the time of the cash flow

What is it?N

the total time of the project

What is it?

r

the discount rate (the rate of return that could be earned on an investment in the financial markets with similar risk.)

What is it?

Ct

the net cash flow (the amount of cash) at time t (for educational purposes, C0 is commonly placed to the left of the sum to emphasize its role as the initial investment.)

The value of money over time

The discount rate10%

Y1Y2Y3Y491%83%75%68%

The discount rate10%

Y1Y2Y3Y491%83%75%68%Why not

Y1Y2Y3Y491%83%75%68%

The discount rateBecause your 10% discount rate is worked out backwards.

Last year was 10% greater than this yearWhy not

Y1Y2Y3Y491%83%75%68%

The discount rate10%

Y1Y2Y3Y491%83%75%68%

So it looks like this

Excel can help

NPV in excelHelp menuNPV

But it aint perfectThe NPV investment begins one period before the date of the value1 cash flow and ends with the last cash flow in the list. The NPV calculation is based on future cash flows. If your first cash flow occurs at the beginning of the first period, the first value must be added to the NPV result, not included in the values arguments. For more information, see the examples below

The calculations in excel are The NPV investment begins one period before the date of the value1 cash flow and ends with the last cash flow in the list. The NPV calculation is based on future cash flows. If your first cash flow occurs at the beginning of the first period, the first value must be added to the NPV result, not included in the values arguments. For more information, see the examples below different

NPV in excelThe NPV investment begins one period before the date of the value1 cash flow and ends with the last cash flow in the list. The NPV calculation is based on future cash flows. If your first cash flow occurs at the beginning of the first period, the first value must be added to the NPV result, not included in the values arguments. For more information, see the examples below

NPV in excel

NPV in worksheets

Financial Analysis

for e-Learning Project 2006

Discount rate

YEARS:

1

2

3

4

Total

Costs

Discount factor

0.91

0.83

0.75

0.68

Discounted costs

Benefits

Discount factor

0.91

0.83

0.75

0.68

Discounted benefits

Discounted benefits - costs

NPV

Cumulative benefits - costs

ROI

Payback In Year:

When is it used?

Assessing the value of a project

NPV is typically used for 2 reasons

2. Choosing which projects get priority

When is NPV used?

Assessing the value of a project

NPV is typically used for 2 reasons

2. Choosing which projects get priority

Assessing the value of a project

NPV is typically used for 2 reasons

2. Choosing which projects get priority

Assessing the value of a project

NPV is typically used for 2 reasons

2. Choosing which projects get priority

When do you use it?Project 1Project 2Compare & ContrastWhich one is best?Costs & BenefitsIs it worth our investment?

Which is the better investment?http://www.flickr.com/photos/makz/56920649/http://www.flickr.com/photos/f2g2/75152105/

Which was the better investment?http://www.flickr.com/photos/orangebrompton/1858900270/http://www.flickr.com/photos/orangebrompton/1858900270/

Questions

What is the discount rate?What is IRR?

What is IRR?Internal Rate of Return

What is IRR?The amount you need to earn to make it all worthwhile

What is IRR?It is based on things like opportunity cost, the cost of money and risk

< 0 < NPV < 0 NPV = 0 NPV > 0The investments return is less than the discounted cash thresholdThe investments return meets the discounted cash thresholdThe investments return exceeds the discounted cash threshold< 0= 0> 0

What is NPV good for?

When does a project manager use NPV?

What project documents (or artefacts) would you find NPV calculations in?

How does NPV help in decision making?

When is NPV not so useful?

What impact does (would) NPV have on your project?

AnswersWhat is NPV good for?

When does a project manager use NPV?What project documents (or artefacts) would you find NPV calculations in?How does NPV help in decision making?When is NPV not so useful?

What impact does (would) NPV have on your project?Understanding the future value of money in todays termsIn presenting the cost-benefit analysis, or justification for a projectBusiness cases, project plans, and project portfolio reports

It helps compare the value of different projects against investment targetsIf a project and its benefits are only going to run for a short period (e.g. less than a year) or if a projects benefits are non financial Reflect on your projects costs and forecast benefits

Another exampleEstimated costs; $1,750,000 in year 1 and $400,000 each year in years 2, 3 and 4.Estimated benefits; $0 in year 1, and $950,000 each year in years 2, 3, and 4. Use a 10 percent discount rate.

Financial Analysis

for e-Learning Project 2006

Discount rate

10%

YEARS:

1

2

3

4

Total

Costs

Discount factor

0.91

0.83

0.75

0.68

Discounted costs

Benefits

Discount factor

0.91

0.83

0.75

0.68

Discounted benefits

Discounted benefits - costs

NPV

Cumulative benefits - costs

ROI

Payback In Year:

Another exampleEstimated costs; $2,500,000 in year 1 and $250,000 each year in years 2, 3 and 4.Estimated benefits; $0 in year 1, and $750,000 each year in years 2, 3, and 4. Use a 10 percent discount rate.

Financial Analysis

for e-Learning Project 2006

Discount rate

YEARS:

1

2

3

4

Total

Costs

Discount factor

0.91

0.83

0.75

0.68

Discounted costs

Benefits

Discount factor

0.91

0.83

0.75

0.68

Discounted benefits

Discounted benefits - costs

NPV

Cumulative benefits - costs

ROI

Payback In Year:

Craig Brownwww.BetterProjects.net

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